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Who wins at forfeits?

The seller in a property transaction should no longer expect that rescission on the buyer’s part will automatically lead to a windfall forfeiture of the initial deposit from the defaulting party, explains Nitej Davda

In any conveyance the aggrieved party has remedies if the other fails to complete. Aside from the usual claims for specific performance and damages, an aggrieved seller will have the additional remedy of rescission of the contract with forfeiture of the deposit paid. This is provided for by Condition 7.5 of the Standard Conditions of Sale (4th edition), used in residential transactions. There is similar provision within the standard conditions of sale for commercial property.

The court’s discretion to return deposits: Tennaro

Standard Condition 7.5 is tempered, however, by s 49(2) of the Law of Property Act 1925: ‘[I]n any action for the return of a deposit the court may if it thinks fit order the repayment of any deposit’.

Section 49(2) qualifies the condition so that a seller’s ability to rescind the contract and forfeit the deposit is subject to the court’s power, on application by a buyer, to order otherwise.

The 2003 case of Tennaro Limited v Majorarch Limited analysed previous decisions and has been seen by buyers as authority for the proposition that if the seller, subsequent to rescission, sells the relevant property for a profit, this ought to sway a court to order the return of a deposit.

Tennaro involved three separate contracts for the purchase of long leases of flats yet to be constructed. A dispute arose as to performance of the contract and whether the seller had validly rescinded.

It was held that the seller had acted properly in each case, following the buyer’s default. The court then had to considerwhether its discretionary powers under s 49(2) ought to be exercised in favour of the buyer. Neuberger J (as he then was) set out the test. First, following the Court of Appeal decision in Universal Corporation v Five Ways Properties Limited [1978], the jurisdiction under s 49(2) is to be exercised where the justice of the case requires. Repayment must be ordered in any circumstances which make this the fairest course between the parties. Second, following the Court of Appeal decision Omar v El-Wakil [2001], that the requirement to repay a deposit should be certain. If it is the buyer who cannot perform the contract and the seller rescinds, only in exceptional circumstances will a court decide that the deposit should be returned.

Change in value

Of the three flats in Tennaro, the court ordered repayment of two of the deposits. Of the deposit that that was to be retained, relating to flat 37, Neuberger J held:

‘On the agreed facts . . . the buyer should have completed the first agreement . . . and it failed to do so because it could not raise the funds. . . [T]hat is the classic circumstance in which a deposit is liable to be forfeited and unless there are special reasons to the contrary, there should be no question of it being recovered by the buyer.’

As to the remaining two deposits, that were ordered to be repaid, the judge held that the situation was more complex to resolve, as the value of the flats significantly exceeded the contractual sale prices. In respect of the first of these, flat 32, he stated:

‘I have reached the conclusion that . . . the deposit in relation to flat 32 should be returned. The seller had the opportunity of selling flat 32 at a price significantly greater than that contractually payable . . . In reaching this conclusion I draw assistance from the reasoning and decision . . . in Dimsdale Developments (South East) Limited v De Haan [1983]. As I understand it [the judge] considered that the fact that the seller had sold the property at a substantially higher price than it would have received under the contract with the defaulting buyer was the crucial factor which justified the return of the deposit.’

Neuberger J’s reasoning was similar in relation to the second property, flat 31: ‘On balance I have concluded that the deposit on flat 31 should also be repayable. First, the seller had the opportunity to complete the flat 31 agreement at the contract price and has not come forward with any explanation as to why it refused to do so. Secondly, based on its then market value, flat 31 could have been sold, on rescission of the agreement, at a price which was . . . significantly over 15 per cent above the [contract] price.’

Neuberger J anchors his judgment in ‘commercial common sense’. Flat 37 was soon worth less than the contract price; flats 31 and 32 increased in value and the judge was able to rely on Dimsdale. Does it therefore follow that increase in value is an exceptional circumstance under the Omar test? Two recent High Court decisions would suggest that the answer is no.

Fixed deposits create certainty

In January this year, in Midill (97PL) Limited v (1) Park Lane Estates Limited and (2) Gomba International Investments Limited [2008] EWHC 18 (Ch), the claimant, Midill, entered into a contract with the second defendant, Gomba, whereby Gomba would sell all its shareholding in the first defendant, PLEL, for £4m. The only asset of PLEL was property on Park Lane, London. Gomba was the sole shareholder of PLEL and subsequently sold its interest for £4.3m.

Payment was to be made in three tranches: £400,000 on entering into the agreement, £800,000 between entering the agreement and completion and the balance on completion. Midill paid the first two tranches but was unable to pay the third. Gomba rescinded the contract and sought to forfeit the £400,000.

The court was not asked to decide whether s 49(2) applied in the case of a sale of shares in a company whose only asset was land, as opposed to a sale of land, because Gomba conceded the point; the only issue here was the application of s 49(2). Midill’s argument for the return of the deposit was that Tennaro was authority for the proposition that a seller rescinding a contract and selling on at a profit wouldconstitute a ‘special circumstance’ sufficient to warrant the return of the deposit.

HHJ Mackie QC found in favour of the seller. He observed that the parties were experienced professionals and the deposit was not a penalty but the normal 10 per cent. In considering the earlier decisions of the Court of Appeal he concluded: ‘. . . in the ordinary way the court will not order the payment of the [deposit] and that applies even if the seller makes a profit on the subsequent sale. If the proposition were otherwise and the liability to repay the deposit depended upon some future sale price there would be considerable uncertainty possibly for a lengthy period. That would create precisely the uncertainty which a fixed deposit is intended to avoid.’

Reconciling Midill with Tennaro

The judge in Midill specifically attempted to reconcile his opinion with that of the judge in Tennaro:

‘The judge found that there were special reasons in respect of [flat 32] . . . where the buyer had before completion [author’s italics] found an alternative purchaser to purchase the flat for substantially more than the contract price.’

Interestingly, HHJ Mackie QC does not refer to flat 31, for which the deposit was also found to be repayable. Further, the judgment provides, ‘there is nothing to prevent the parties providing . . . that liability to repay the deposit . . . will depend upon the outcome of a further sale.’

It is submitted, however, that this would fetter the court’s discretion under s 49(2), thereby rendering the proviso ineffectual.

The court’s most recent interpretation:

Aribisala v St James’ Homes

In Aribisala v St James’ Homes (Grosvenor Dock) Limited the claimant contracted to purchase two properties. In each case the standard conditions quoted above were incorporated but were amended by the words, ‘Section 49(2) of the Law of Property Act 1925 shall not apply’. The claimant commenced an action for specific performance of the contracts, alternatively a return of the deposits paid. At the first hearing, in June 2007, the judge was of the view that the purpose of

s 49(2) was to give a defaulting buyer some hope of recovering its deposit, where appropriate and that the parties could not contract to negate the court’s power under s 49(2).

The sole issue at the trial, in March 2008, was whether the court’s unfettered discretion under s 49(2) should be exercisedin favour of the claimant. In support of his contention that the deposit ought to be returned to him in each case, the claimant relied upon ten factors, of which the profit made by the seller was one. In this regard the same passages in Tennaro were relied upon as by the buyer in Midill.

In dismissing the suggestion that Omar and Tennaro were authority that a vendor who makes a profit following rescission is an exceptional circumstance, Floyd J held that the cases are nothing more than authority for the proposition that profit or loss on a subsequent sale is merely a factor under s 49(2).

No automatic return of deposit when seller has rescinded and a profit made on resale.

While it is understood by the author that both recent decisions are the subject of appeal, their effect at present is that Tennaro cannot be cited as authority for the proposition that a vendor who makes a profit as a result of rescission will be required to repay a deposit. However, both decisions rely upon the specific facts surrounding flat 32, while appearing not to consider the facts surrounding the decision on flat 31; there may yet be scope for further judicial distinction. The flat 32 position was exceptional because there was still anopportunity for the vendor to sell the flat, on a date close to the contractual completion date, at an increased price, to a new buyer who was found by the defaulting buyer. The seller, for reasons that he failed to explain to the court, chose not to avail himself of this opportunity. It was this unexplained conduct that was the deciding factor why the deposit for flat 32 was held to be repayable, as opposed to the increase in price that could be attained.

When advising clients who are faced with the possibility of a defaulting buyer it is important that the rescinding party considers all of the facts of his or her particular case and does not automatically assume that rescission will result in a windfall forfeiture of the deposit. While in a rising market the mere fact that prices have increased is insufficient to warrant a repayment of the deposit under s 49(2), an outright (and unexplained) refusal to deal with a prospective purchaser who wishes to buy for more than the previous contract price may well result in the seller having to return the deposit to the buyer and rely instead upon his remedy of damages.

Compare jurisdictions: Arbitration

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